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The U.S. auto industry ended 2018 with sales of 17.3 million new vehicles, which beat expectations, but the outlook for 2019 is uncertain. Among the twists and turns on the road ahead are the fallout of a slowdown in China and in the U.S., the overhang of tariff wars, the impact of new technologies such as driverless vehicles, and the preferences of millennial and Gen Z consumers, which will drive future demand.
If the past year saw plant closures and layoffs at companies such as General Motors, the industry heads into 2019 with more investments, alliances and forays into electric vehicles and other newer technologies. While the industry began the year on a tepid note with an expected sales decline in January, it does not mean auto companies won’t ride out any bumps, according to experts at Wharton and elsewhere.
Long and Winding Road
Pros and cons exist for each of the factors influencing the U.S. automobile industry, notes Wharton management professor John Paul McDuffie, who is also director of the Program on Vehicle and Mobility Innovation at the school’s Mack Institute for Innovation Management.
“For each one there could be a positive spin and positive angle on it, and a negative spin and a negative angle on it,” McDuffie said. He saw the industry facing “a decent amount of uncertainty,” and that he was neither optimistic nor pessimistic about the year ahead. “We live in interesting times, turbulent times.”
MacDuffie believes the auto industry is dealing with a broader range of issues than he has encountered in the many years he has studied the industry. He pointed to technological changes, electric and autonomous vehicles, the current state of trade and the threats of tariffs. On the tariffs front, the U.S. auto industry is bracing for higher duties on steel and aluminum imports after April, when a 90-day suspension of higher tariffs by the U.S. on imports from China expires. The industry is also worried about the impact of tariffs that President Trump has threatened to impose on car imports from the European Union.
Concerns loom about the strength of various economies – the U.S. and China in particular. “As big a concern as the tariff risk is the risk of China’s economy slowing way down,” said MacDuffie. The Chinese market has been “the main engine” for many of the global automakers, he added. “I wonder what it’s like to be a senior executive in these auto companies and have to deal with this amazing complexity and this amazing uncertainty.”
“As big a concern as the tariff risk is the risk of China’s economy slowing way down.” –John Paul MacDuffie
Paul Eisenstein, publisher and editor of TheDetroitBureau.com, a publication focused on the automobile industry, noted that while the consensus was that 2018 would be a year of decline in the U.S. market and China would grow slower than it had in past years, exactly the opposite happened. “The U.S. actually gained, albeit by just a hair’s breadth in 2018, and China posted its first decline that we’ve seen since the explosion of that market back around the turn of the new millennium,” he said. “Most people expect that China will rebound a little bit this [year] and the U.S. market will again slow.”
Above all, much depends on President Trump’s actions, said Eisenstein. “He is continuing to talk about ramping up his trade wars,” he noted. The industry is preparing for the outcome of some key negotiations such as those between the U.S. and the European Union, he added.
MacDuffie and Eisenstein shared their insights on the emerging terrain for U.S. auto industry for a series titled “2019: A Look Ahead” on the Knowledge@Wharton radio show on Sirius XM. (Listen to the podcast at the top of this page.)
Tesla Plugs into China
One automaker that is bullish on China even as the country grapples with an economic slowdown is Tesla, which is planning to build a factory there. “Tesla is always out there at the risky edge of something,” said MacDuffie, noting that it wants to build a new factory in China even as its own finances are stretched. On the other hand, he pointed out that Tesla is the first foreign company that China has allowed to build a plant on its own without a Chinese joint venture partner. “That means less chance of knowledge leakage and having to share information [with Chinese firms or the Chinese government]. But it also means the risk is not shared anymore.”
Also encouraging for Tesla is the fact that the Chinese government is pushing on several fronts to be the biggest electric vehicle market in the world, MacDuffie said. “They have a lot of levers at their control to make that happen, including being able to require that foreign automakers make a lot of electric vehicles to sell there. So, it’s not so risky for [Tesla founder] Elon Musk to figure that in building capacity there, there will be demand for electric vehicles.” The $2 billion project could start selling its cars by as early as the second half of this year, according to a Quartz report that cited Chinese government officials.
At the same time, many Chinese startups that have come in to try to compete at the high end of the electric vehicle market have struggled, MacDuffie said. He pointed to Faraday Future as one of those. “It had seemed to be amply financed and had a lot of good talent, and they’ve had nothing but trouble. So, it’s a risky bet to make that big of an investment [as Tesla is planning in China]. But as a bet on a market that’s going to have electric vehicle demand, it is not so much [of a risk].”
Eisenstein noted that consensus is growing in the auto industry that “electrification is the way of the future.” While global sales of all electric vehicles, including hybrids, plug-ins and pure battery electric vehicles still run below the 5% mark, “you see a definite and increasingly sharp upward curve that tells you that you avoid the electric market electrification at your own peril,” he said. China is an attractive market for electric vehicles, he added, noting that it has introduced rules that will require automakers to produce a minimum level of plug-in models that can operate in certain conditions in zero emissions mode.
Similar regulations are also expected in the U.S. in 2025 with new fuel economy standards, although the Trump administration has said it would roll them back, said Eisenstein. He pointed to several actions by U.S. automakers to diversify into electric vehicles. One is Ford Motor’s announcement that it will launch an all-electric version of its F series pickup, which Eisenstein said is the best-selling vehicle in the U.S. General Motors is also planning all-electric versions of the Chevrolet Silverado and the Sierra, he added, referencing his report on the development.
U.S. Auto Investments: Divergent Trends
While some U.S. automakers are cutting back capacity at plants that no longer bring in the desired revenues and profits, their foreign counterparts are making fresh investments. A case in point is the decision General Motors made last November to close five plants in North America, lay off some 14,000 workers, and retire six of its 15 car models. The GM move “wasn’t a big surprise if you simply looked at how much the demand for the products made in those plants had slowed way down over a period of a couple of years, and the general shift away from sedans to SUVs,” said MacDuffie. “The hard-won wisdom is that it’s better to make these cuts in good times than wait for bad times and when you may have actually made them worse.” He expected such “adjustment of employment to the market demand” to continue.
“We live in interesting times, turbulent times.” –John Paul MacDuffie
For the foreign auto companies, the U.S. is still the biggest market in the world, next to China, said MacDuffie. “To come here, to build here, to build brand here, and to build reputation here still makes sense.” That logic explains Volkswagen’s move to invest $800 million to make electric vehicles at its plant in Chattanooga, Tenn., and a joint venture between Toyota and Mazda in an assembly plant in Huntsville, Ala., he added.
“They’ve got demand for those vehicles here and it’s a way to be protected against some of the risk of tariffs. Employment will go up and down across plants, and across companies. It’s the overall picture of growth for the industry in the world economy that probably these companies are really watching.”
Alliances vs. Mergers
Another trend that Eisenstein highlights is alliances between automakers. He listed the Ford-VW partnership to make commercial vans and pick-up trucks, the Honda-General Motors partnership for autonomous vehicles, and the Toyota-Mazda joint venture. However, “you’re not going to see many of these alliances become full time partnerships or marriages,” he said. Others include Toyota’s partnership with Panasonic to develop electric batteries, which also happens to have partnered with Tesla. “These are limited, anti-monogamous ventures. A great example is Toyota. For most of its existence, it kept away from anything tying it to another manufacturer. But just in the last couple years we’re seeing it tie up with BMW, Mazda, Subaru and so on.”
MacDuffie recalled that Sergio Marchionne, the former CEO of Fiat Chrysler who passed away last July, made a strong case for consolidation in the auto industry. “He was famous for predicting that the industry was inevitably going to have to consolidate to a small number of big players because he felt [that considering] the economies of scale, it was incredibly wasteful of capital to have all these firms developing all those vehicles,” he said.
Even so, the industry has a long history of failed mergers, MacDuffie noted. The Nissan-Renault Alliance that eventually included Mitsubishi has been described as “the most successful long-term relationship that wasn’t an outright merger,” he said. However, the alliance is facing testing times after the recent arrest and the resignation of its chairman, Carlos Ghosn. Even so, “it still has some inherent strengths if they can figure [a way out of the crisis],” he added. The issues on the table are new governance mechanisms and the balance of power between France (Renault) and Japan (Nissan), he pointed out.
MacDuffie said he has never been optimistic about such consolidation attempts. “I’ve always thought that consolidation to a small number of companies was unlikely, that what was more likely would be a whole lot of projects in which costs are shared, and where it’s advantageous for the partners.” He cited a partnership between Toyota and Peugeot in a diesel engine project in Europe, which worked well for several years, but was disbanded as the technology changed. Incidentally, Peugeot’s parent Groupe PSA recently struck another partnership with Toyota. Similarly, Toyota and Volkswagen had partnered to make pickups many years ago, and “they moved in and out of that,” he added.
“You could see these as failed projects or you could see them as very pragmatic, often short-term calculations to deal with cost pressures, needs for technology, needs for a product in the short term,” said MacDuffie. “It’s actually a healthy adaptation to all the volatility and uncertainty as opposed to the big bet like a Daimler-Chrysler merger, which eventually failed.”
Used Cars Preferred
One industry trend to watch is increased car buyer preference for used, rather than new, vehicles, especially if the latter are of recent vintage with the latest or near-latest safety and other features.
Eisenstein said that “prices [of new cars] have gone up to near record levels” of between $35,000 and $40,000 each “for a typical vehicle.” He added that even those who can afford new autos at those prices are actively considering certified pre-owned vehicles. “Typically, [they are] off-lease, which means that buyers took good care of them because they would otherwise be penalized on the return,” he noted. “They are a year or two old and often identical to the models that are in the showrooms as new vehicles. That is something the industry has created, and it has become a threat to its own new car market.”
From the standpoint of dealer margins, those trends seem to make sense. “One of the relatively well-known secrets of dealer economics is that new cars have lower margins than used cars, which have lower margins than repair, which have lower margins than aftermarket parts.,” MacDuffie said. “To the extent that the dealers are the ones in the certified pre-owned vehicle market, they probably do well.”
Ridesharing and Autonomous Vehicles
Eisenstein also noted trends in the ridesharing and car-sharing markets. He said one “significant” development of the past year came from Waymo, a spin-off from Google’s parent Alphabet, when it announced the launch of its robotaxi service Waymo One. He wondered whether it would be “truly autonomous” or have “backup operators” behind the wheel.
“If they’re able to make this work, and if the drivers don’t have to constantly intervene, they may get approval within the next year or two to start fielding completely driverless vehicles,” Eisenstein said. “That changes the equation because if you take the driver out, the biggest cost of a ride sharing vehicle goes away. Suddenly you potentially make it possible for companies like Waymo One, Uber, Lyft and some of the others that are coming to undercut the idea of owning a vehicle, particularly in urban markets that may get thousands or even millions of drivers to abandon the idea of personal vehicle ownership.”
“Millennials basically saved the industry from a second consecutive year of decline.” –Paul Eisenstein
MacDuffie said 2018 was “a year of a little bit of realism and retrenchment” in the advancement of autonomous vehicles. He pointed to a fatality last March in Phoenix involving an Uber car as one of the big setbacks. “We’re going to see more and more experimentation, and more and more pilots [in 2019],” he said. “The pilots help the companies learn and get better, improve their algorithms, and it lets the public see these new things, and be more realistic about what works and what doesn’t. It’s a slow movement towards both improvement and public acceptance.”
Millennials to the Rescue
MacDuffie pointed to another driver of the industry’s fortunes: the emergence of millennials as active car buyers. “For a while, everybody said millennials don’t care about cars anymore, they only care about their gadgets and that’s a generational shift that will shake up the auto industry,” he said. “It now looks like as millennials get older, they get married, they move out of the cities to the suburbs, they have kids, they’re buying cars and maybe their finances now allow them to do that too. That’s a kind of unexpected source of demand.”
The U.S. auto industry booked solid sales gains last year, exceeding 17 million vehicles for the fourth year in a row. “If we go from 17.2 million to 16.8, it’s actually not a tragedy for the industry,” MacDuffie said. “It’s almost expected because we’ve had these surprises (such as the demand from millennials) that it hasn’t made that dip yet.”
“Millennials basically saved the industry from a second consecutive year of decline,” said Eisenstein. “Every analyst I’ve talked to said that it was largely an increase in millennial sales that surprised them. We are likely to continue to see that as they get older, they get wealthier and they can start buying new vehicles.” However, over time he expected millennials (those born between 1981 and 1996) and the Gen Z population (those born between 1995 and the early 2000s) to opt for used vehicles, either because they want to be “smarter about their money” or “tighter with their budget” if they are saddled with college loans.
What vehicles those new buyers prefer is another big question for automakers, Eisenstein said. “Will they switch to electrified vehicles or clean vehicles? Will they also continue the push into crossovers and conventional sport utility vehicles? [Some of the younger buyers] are saying ‘I don’t want what dad had.’ So, there’s a lot of uncertainty about where the millennial generation and the next generation will go.”